Today, I swapped out of SDS and purchased DBA to replace it. Let’s walk through the trade as it alters the Top Five.
As a review, SDS is an levered ETF that performs 2x opposite of the market’s daily return. I originally made the purchases in September and December 2009 because I wanted to hedge my long positions with a market short position in a long-only account. After making some tactical errors, I learned that levered ETFs should not be owned by investors with time horizons longer than a day. Here’s why…
Arithmetic versus Geometric
Most people understand an average to be an arithmetic average. That is, in a series of returns {+50%,-50%}, the arithmetic average is 0%. However, the geometric average takes into account previous movements. The same series above thus yields -25%, where 1*(1+.50)*(1+-.50) = 0.75. The longer an investor holds this position, the longer he is exposed to the compounded downward effect of the leverage more so than the levered upward gain. Over time, this diminishes investor returns. Consider this example of a levered long oil ETF and a levered short oil ETF:
The Proshares Ultra Oil & Gas ETF (
DIG) and UltraShort Oil and Gas ETF (NYSE:
DUG) are the respective double long and double short for the IYE benchmark. During the 2008 period of massive oil price fluctuations, DUG lost a very respectable 19%, while DIG came over the top with a 69% loss.
Source:
Investopedia
As soon as an investor holds a levered ETF for more than a day, he is exposed to this effect. Back to my SDS example, I wanted to short the market. Even though the market moved against me for an expected loss of 20%, the compounded levered downward effect resulted in a loss closer to 30%.
| 9/15/2009 |
SDS |
50 |
40.9 |
$ (2,052.00) |
| 12/1/2009 |
SDS |
50 |
35.64 |
$ (1,789.00) |
| 10/3/2011 |
SDS |
100 |
26.511 |
$ 2,644.04 |
| |
|
|
|
$ (1,196.96) |
The Good News
The good news is that investors can take advantage of these securities by shorting them. For example, in a margin account, I shorted SSO in Decemer 2010. Since SSO is levered to the market, and I believe the market will fall, shorting SSO enables me to take a bearish position and benefit from the downward leverage.
Swapping to DBA
With cash from the sale of SDS, I purchased DBA, an agriculture ETF. The main purpose for buying DBA is that I needed a place to park money. Since I already have a significant cash position (see asset allocation), I needed a relatively safe asset that benefits from long term rising prices, is safe, and is not US Treasuries. DBA seems to fit the bill, for now.
Overlap
By owning DBA, I have substantial overlap with two existing holdings: DBC (commodities) and JJG (grains). Over the next several weeks (or months), I will likely trade out of one of these positions, possibly by selling calls. While having three positions with overlap is not ideal, it allows me some trading flexibility in the near term. The DBA purchase was 100 shares at $29.70 per share.
Top Five is updated accordingly.
